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Ivan Fučík | September 12, 2014

Repairs of technical improvement of rented premises?

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If you wish to open a shop or some other business premises, for example a restaurant, and you are dealing with the question of whether or not the initial investment can be included in costs, read on. I will outline the options for you, which the current legal regulation enables. More specifically, I will be writing about that part of your investment, with which you are refining or adjusting the real estate you have rented.

There is a general rule that expenditure on long-term assets is not a cost deductible from the taxes, but they lower the tax base in the form of depreciation. If you are refining or adjusting already completed property in use, it is so-called “technical improvement” of existing property. This is true for all assets including buildings. According to the law, such “technical improvement” is being depreciated for the same period of time as the improved asset. For buildings it is 30 or 50 years depending on the type of building and its inclusion in the 5th or the 6th depreciation group.   “Technical improvement” is an accounting and tax category, which public law does not know. You will find a definition in article 33 of the income tax act.  “Technical improvement is always understood as expenditure on completed structures, superstructure, extension and construction adjustments, reconstruction and modernisation of assets, if exceeding a sum of CZK 40,000 for the taxable period for the individual asset item.” The law then describes in greater detail, what is a superstructure, extension and construction adjustments, reconstruction and modernisation. If you have a feeling that it is rather complicated already, I must say that this is not all, yet. The problem is that in case of lease, you are improving another person’s real estate and not your own. Only its owner can depreciate. According to the law, the lessee and nowadays even a sub-lessee can depreciate, only with written approval from the owner. The latter must, in turn, commit to not depreciating.


This way all merely dry theory of the law. But how does it look in practice? Contracts of lease of new premises are usually made for 5 years, 10 years at maximum. You will see the day, when the entire initial investment is depreciated, after 30 or 50 years. In other words, you will not be able to get a major part of the initial investment into costs at all. Why? Because this is how the state wanted it and wrote it in the law this way in the 1990s already.

And this is often where the work of us tax advisers begins. We are looking to see, if there are options to be found in the above mentioned situation, so that a part of the investment could be deduced from the tax base after all.


How to proceed, then?

The first question is, if the mentioned refinement of rented premises represents technical improvement of repair. Repair is a tax-eligible cost. Technical improvement, as we have explained above, is not one-off tax expenditure. The question to such an answer usually is not easy in the specific case. Repair removes the effects of partial physical wear or damage for the purpose of resuming a previous state or a functional state. This is how accounting rules define it. In case of resuming a functional state, other materials, components, parts or technologies may be used that those originally use, as long as this does not constitute technical improvement. Repair in the sense of article 652 paragraph 2 of the civil code valid until Dec 31, 2013 is an activity, which removes faults of a thing, consequences of its damaging or the effects of its wear. A similar conclusion that repair is an activity removing faults and damage to a thing, returning a thing to its original state or to a functional state (see article 1268, 2210, 2169 and 2287 of the New civil code). It follows from these formulations that repair is an activity and cannot have a different purpose that returning the asset to a state, in which it previously existed, or to a state, in which the asset is functional.

I recommend verifying, if the cost expended does not constitute technical improvement, by negative comparison with the definition of technical improvement. Technical improvement is not a cost related to superstructure, extension, construction adjustments, reconstruction or modernisation. Or it does not exceed a sum of CZK 40,000 per year for one asset item.

A second related question is, if it is possible to separate repair from technical improvement? In general, I would answer that it is not, but there are situations, when it is possible to imagine, according to the SAC. The answer to this question is purely individual.

The third question is, if your adjustments are really part of the rented real estate? According to established practice, anything firmly connected to a real estate item is part of it. If you request a binding opinion of one of the specialised “classifying” offices, you will most likely receive such an answer, too.  But it may not be the case. According to a decision of the SAC, only that, which shares its function and purpose, is part of a thing. (NSS 5 Afs 3/2010 - 148, from Sep 17, 2010).

In the quoted ruling, the court adjudged: “In the sense of an explanatory note to supplement no. 1 of the income tax act, to which the complainant refers, equipment, which enables the function and purpose, for which the structure was intended and approved for use, are also considered part of the structures. Their dismantling would not doubt result in devaluation of the function and purpose of the structure, because production, for which the structure was intended, could not take place.”

The court further adjudges that: “Following the above, it is possible to reach the conclusion that a thing, the equipment, which a structure requires from the perspective of the construction act for the function and the given specific purpose of the structure, will usually be part of the structure for the purposes of the income tax act. A contrario, that, which, from the perspective of the functioning of the structure, is not required for the given purposes from the perspective of construction and technical requirements, usually will not be considered part of the structure from the perspective of the income tax act.”

The court further mentions some examples for illustration. If it is not part of the structure, it cannot be its technical improvement either, but a separate asset, owned by the lessor, and he can thus independently depreciate it. In most cases considerably faster than the buildings.

What to say in conclusion?  I must point out that in order to substantiate your claims, you need confirmative material of high quality. I mean photographs before and after carrying out adjustments, projects, statements from construction engineers, contracts for work and invoices corresponding to the actual scope of adjustments carried out. And in addition to this all, I recommend the services of a tax adviser. Let him advise you on what can be done and what cannot. I wish you many successful years in new rented premises.